Bear Stearns Told to Pay $160 Million To Investors

By JULIE CRESWELL

Published: February 16, 2007

A federal bankruptcy judge yesterday ordered Bear Stearns to pay nearly $160 million to investors in a hedge fund for failing to properly monitor the activities of the fund before it collapsed in early 2000. The ruling could force Wall Street firms to step up oversight of some of their most lucrative clients.

Servicing hedge funds is one of the fastest-growing businesses on Wall Street. Called prime brokerage, these activities -- which include finding and lending stock to allow hedge funds to sell short (betting their price will fall), structuring derivatives and executing swaps -- account for about $8 billion in annual revenue, according to the Vodia Group, an advisory firm in the securities lending market.

The Bear Stearns case involved Manhattan Investment Fund and its Austrian-born manager Michael W. Berger. The fund lost nearly $400 million of investors' money by making wrong bets on Internet stocks during the technology boom of the late 1990s.

In the year before the fund imploded and as suspicions grew among executives inside Bear Stearns that Mr. Berger was providing fake account statements to investors, he transferred $141.4 million to the fund's account at Bear Stearns to meet increased margin requirements and continue selling stocks short, betting that they would decline in value, court filings state. That $141.4 million was used to cover all the positions in the market for which Bear Stearns would have been liable.

Yesterday, the judge said that $121.1 million of the transferred payments had to be returned to investors with interest.

In an opinion issued last month, the judge overseeing the bankruptcy, Burton R. Lifland, said that Bear Stearns, which made $2.4 million in profits from executing transactions for the fund, ''failed to act diligently in a timely manner,'' noting that individuals inside the investment bank may have been aware of the fraud dating back to 1998. Bear Stearns said it planned to appeal the decision. ''We are disappointed with the bankruptcy court's decision, and believe that it is not supported by either the law or the facts,'' the investment bank said in a statement.

Regulators are examining some of the relationships between securities firms and their hedge fund clients, including arrangements that allow hedge funds to lease space from investment banks, as well as the possibility that individuals inside Wall Street banks may be leaking information about big trades to hedge funds to curry favor.

The ruling in the Bear Stearns case, however, surprised many on Wall Street, who say that if it stands on appeal, prime brokers may no longer be able to argue they have a hands-off business of simply executing trades for the funds. Some said that Wall Street firms might need to bolster their market surveillance programs to try to catch odd transactions or false statements.

''Risk management at these firms are all going to take notice of this case and are likely to review their own internal controls,'' said a lawyer who spoke on the condition that he not be identified because he represents firms in the industry.

Among its arguments to the bankruptcy court, Bear Stearns warned that any finding that it had control over margin payments under boilerplate agreements used throughout Wall Street could ''expose all other broker-dealers to 'massive' amounts of liability and would cripple the securities industry.''

In early January 2000, the Securities and Exchange Commission accused Mr. Berger of committing a fraud on investors nearly as soon as his fund began trading in mid-1996. With tech stocks booming, Mr. Berger believed that the stock market, and particularly Internet stocks, was overvalued and would decline sharply. He began aggressively selling securities short, according to court filings by the S.E.C.

As the stock market, and Internet stocks, continued to climb, the fund's losses mounted. To hide those losses, Mr. Berger created fake account statements that were provided to the fund's investors, its administrator and auditors, the commission said. He used money from new investors to make payments to early investors, filings in bankruptcy court state.

Mr. Berger pleaded guilty to securities fraud charges in late 2000, but failed to appear at his sentencing hearing in the spring of 2002 and remains a fugitive.

According to bankruptcy court filings, in December 1998, a senior managing director for Bear Stearns was told by a person he met at a party that the Manhattan Investment Fund was reporting to investors a 20 percent profit for the year. The Bear Stearns executive, however, had understood that the fund was losing money based on risk-related conference calls at the firm.

The Bear Stearns executive eventually confirmed with the firm's internal records that the fund was losing money in its Bear Stearns account. He passed that information along to the firm's senior management, which resulted in a call between other Bear Stearns' executives and Mr. Berger

During that conversation, Mr. Berger said the discrepancy was a result of Bear Stearns being only one of eight or nine prime brokers.

In his ruling in January, Judge Lifland said that while Mr. Berger's explanation may have been plausible, Bear Stearns did nothing to verify this information which, when checked months later, showed the firm was the only prime broker for the fund. Yet, there were signs that executives inside Bear Stearns were nervous about the fund's activities, court filings say.

In September 1999, as Bear Stearns internal records showed that the fund was down sharply for the year, Bear Stearns raised the margin requirement on the fund to 50 percent from 35 percent, according to bankruptcy court filings.

To meet its increased margin requirements, the fund transferred and deposited into its Bear Stearns account the $141.4 million in margin payments.